This week marks the fifth anniversary of the inception of the NDW Tactical + Ladders Fixed Income Model.
This week marks the fifth anniversary of the inception of the NDW Tactical + Ladders Fixed Income Model (LADDERS.TR). The LADDERS model combines the State Street Fixed Income Model (SSFIXED.TR) with two “ladders” composed of BulletShares target maturity ETFs, one investment-grade (CORPLADDER.TR), the other high yield (HYLADDER.TR). The model weighting is 30% SSFIXED.TR, 30% HYLADDER, 40% CORPLADDER.
While long-term rates have come down from their recent highs, uncertainty remains. As we discussed yesterday, when the Fed cuts rates amid a relatively healthy economy/equity market, long-term yields have often been higher a year later. With that in mind, we thought this would be an opportune time to review the model and how its components – bond ladders and tactical fixed income strategies – can help navigate that uncertainty, which can be challenging for many traditional fixed income strategies.
The role of the model’s two bond ladders is to provide stability and a steady stream of income. The target maturity funds that make up the ladders hold individual bonds that each mature or are expected to be called in the same year. Each ladder has five equally weighted “rungs,” i.e., holds five ETFs with target maturities from one to five years. The ETFs in the ladders are held until maturity at which point the proceeds from the maturing fund are reinvested out to the furthest rung on the ladder. The model is rebalanced once per year when the current year’s BulletShares funds mature.
Because one-fifth of each ladder matures every year they produce a series of known cash flows, which can be a useful tool for investors, like retirees, that need to make regular withdrawals from their portfolio. Target maturity funds also protect against capital losses due to rising interest rates. If the ETFs are held to maturity, investors receive their share of the par value of the underlying bonds (after fees and expenses and excepting for any defaults). The ladder structure also has the effect of increasing the yield of the portfolio over time. All else being equal, five-year bonds have a higher yield than one-year bonds and after five years, the entire portfolio will be made up of bonds that were purchased when they had five years until maturity. Therefore, assuming rates remain constant, the yield of the “seasoned” portfolio should be higher than it was at inception. The individual funds within each ladder are not rebalanced as the goal is to hold them to maturity thereby mitigating the interest rate risk of the portfolio.
The State Street Fixed Income Model is the tactical portion of the model, and its role is to generate alpha. SSFIXED has an inventory of over 20 ETFs covering virtually every area of the fixed income market from convertible bonds to emerging market bonds to long-term Treasuries. The model utilizes a relative strength matrix to evaluate the inventory, identify areas of strength, and avoid areas of weakness in the market. Because of its highly differentiated inventory and tactical nature, SSFIXED’s yield can vary greatly depending on which funds are in the model portfolio at any given time and can exhibit higher volatility than more vanilla fixed income portfolios, which can be problematic for some investors. However, by combining SSFIXED with the laddered portfolios we can achieve a relatively consistent yield and dampen the overall portfolio volatility while retaining the opportunity for outperformance via SSFIXED’s tactical rotation. SSFIXED currently has exposure to senior loans, high yield bonds, emerging market bonds, and international corporates.
Each of the bond ladders can also be found as a stand-alone model on the models page, which allows for either or both ladders to be used in conjunction with other tactical strategies. It also allows the ladders and tactical strategies to be combined using weightings other than the 30-30-40 allocation of the LADDERS.TR model. For example, if you wanted a higher yield than the standard model provided, you could increase the weight of HYLADDER and reduce the weight of CORPLADDER. Tactical fixed income strategies are also available through separately managed accounts and can similarly be combined with a laddered bond portfolio for stable income. If you’re interested in learning more about SMA options, please contact Andy Hyer at (626)535-0630.
Year-to-date (through 10/8), the LADDERS model has gained 4.87% but lagged its benchmark, the iShares US Core Bond ETF (AGG.TR), which is up 6.4%. The tactical portion of the model has been primarily invested in international and non-core US fixed income and the corporate ladder has relatively low duration so AGG has benefited more from the decline in long-term yields this year. However, over the longer-term LADDERS remains well ahead of the benchmark. Over the trailing five years, roughly since its inception, the model has produced an annualized return of just over 2%, while AGG’s annualized five-year return is -0.37%. The model has also produced less than half the volatility of the benchmark as shown by its relative risk (RRISK) of 0.21 compared to AGG.TR’s RRISK of 0.49.
Since the model’s inception in 2020, we’ve gone from the COVID-era ultra-low rate environment through the most aggressive tightening of monetary policy in recent history. At some points, the tactical sleeve has been the primary driver of the model’s returns, while at other points it has leaned on the stability of its two ladders. The complementary pieces of the model have combined to provide alpha relative to the benchmark with lower overall volatility.
